With these purchases, Page Mill Properties hopes to make opportunistic profits for itself and its partners (annual return on investment > 13%) at the expense of the City of East Palo Alto and its low-income citizens. EPA tenant-landlord relations are governed by the City's Rent Stabilization Ordinance. For details on Page Mill's East Palo Alto holdings, corporate structure, and property pricing, click here. Additional information on Page Mill's EPA business plan can be found in the document archive.

What is predatory equity?

Predatory equity is a real estate investment scheme that operates as follows:

2) The firm obtains equity from both private and public sources by promising a high return on investment (ROI). This equity is then typically leveraged with bank loans at values ranging from 60% to 80%. The returns are commonly referred to within the industry as opportunistic, an annual ROI > 13%. It should be noted that the annual ROI for the US stock market, when averaged over the past 90 years, is 10%; for the US bond market, 7%. Predatory equity deals are frequently over-leveraged in the sense that rental income at the time of purchase is not high enough to support the debt service (see Wachovia's Role for details).

3) After purchasing the property, the firm works to raise rental income to meet debt service requirements. The firm and its partners often see income go down during the first few years due to expenditures on capital improvements. Capital improvements are frequently used as a public relations tool to defend the firm's actions in the community.

4) Rental units are recaptured from the local rent stabilization ordinance and raised to fair market value using a two-pronged strategy. First, the firm engages in litigation against the local municipality and pertinent ordinances governing tenant-landlord relations in an effort to weaken their regulatory authority. Second, aggressive tactics are used to encourage pre-existing tenants to voluntarily vacate their units. Under a California law known as Costa-Hawkins, voluntarily vacated units may be brought to fair market value. Target turnover rates the first year for pre-existing tenants generally range from 20% to 30%, with a target of 10% for each year thereafter.

5) The firm and its partners sell the portfolio in five to ten years time after achieving a substantial increase on the annual rental income for the portfolio by replacing low-income tenants with tenants capable of paying significantly higher rents. This increase in rental income translates directly into profit margin on the initial investment according to a standard cap rate calculation. The firm may also profit on the front end of the scheme through acquisition fees charged at the time the properties are acquired on behalf of investors. Additional sources of profit may include property and fund management fees.

It is very important to note here that Page Mill's business plan may differ from this model on one significant point. Rather than replacing tenants that have voluntarily vacated their units with tenants capable of paying higher rents, Page Mill may intend to demolish existing buildings or attempt to meet the threshold vacancy rate required for condominium conversions. A comparison of Page Mill's portfolio wide vacancy rate of 24% with the 5-6% currently typical for the rest of the Bay Area rental housing market suggests this may indeed be the case. With 25% of all housing units in East Palo Alto under their ownership, Page Mill can easily meet the city wide threshold vacancy rate of 4.1% required for condo conversions under the local ordinance.

For more information on this topic, please see Gretchen Morgenson's May 9, 2008, New York Time's article on predatory equity. Additional information on predatory equity can be found in the document archive. Unfortunately, predatory equity schemes have become common practice across the country in recent years.

What kinds of tactics are being used to recapture rental units?

As noted above, rental units are recaptured from the local rent stabilization ordinance by challenging its regulatory authority and by using aggressive tactics with pre-existing tenants.

The company's challenges to the rent stabilization ordinance (RSO) have included the following:

1) Page Mill argued that rent increases allowed under East Palo Alto's RSO in previous years can be banked if prior owners did not exercise an increase in a given year. Intertwined with this banking issue is the company's argument that the Certificates of Maximum Legal Rent are binding despite the apparent failure of previous landlords to submit required vacancy registration information to the City. ALJ rulings dated January 4, 2008, and April 21, 2009, addressed these issues.

2) After establishing separate LLCs for each parcel, Page Mill claimed that units in buildings with four or fewer units qualified for the 'mom and pop' exemption in the RSO, arguing that the owner of record owned no more than four units in the City. 4% of the portfolio's roughly 1800 units fall into this category. Tenants contested this assertion, and the issue is currently being litigated (San Mateo County Superior Court #CIV 478796). On September 28, 2009, the Court issued a preliminary injunction stating the plaintiffs showed a reasonable probability they would prevail on the merits that the RSO applies to the LLCs as alter egos of one another.

3) In letters dated December 31, 2008, January 29, 2009, and February 19, 2009, Page Mill applied for exemptions from the RSO for all buildings with five or more units based on claims of substantial rehabilitation. 96% of the portfolio's roughly 1800 units fall into this category. The petitions were ultimately denied by the Rent Stabilization Board and the matter is now before the San Mateo County Superior Court (#CIV 482848).

4) In a letter dated June 30, 2009, Page Mill asked the San Mateo County LAFCo to remove the portion of East Palo Alto west of Highway 101 (i.e. the Woodland Park Apartments portfolio) from the City's sphere of influence. LAFCo later voted to maintain the City's current sphere of influence.

The aggressive tactics used to encourage pre-existing tenants to voluntarily vacate their rental units include rent increases in excess of the allowable increase set by the City's RSO, premature pay or quit notices, lease terminations, lease non-renewals, insistence on substantive changes in terms of existing leases, excessive late fees, unheeded maintenance requests, etc. Together, these tactics constitute a pattern of systemic harassment designed to replace low-income tenants with tenants capable of paying significantly higher rents.

In what is commonly described as a predatory equity scheme, Page Mill Properties, a Palo Alto based real estate investment firm has purchased 1818 rental units since late 2006 in the Woodland Park neighborhood of East Palo Alto. This neighborhood is bounded on its eastern edge by Highway 101 and on its western edge by San Francisquito Creek. Page Mill's East Palo Alto holdings are shown below in yellow:

Doing business as Woodland Park Apartments, Page Mill Properties has managed to acquire roughly 50% of the City's rental housing stock in less than two years for a total purchase price of $270 million.